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China removes the USD peg


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Lots of conflicting analysis floating around about China so who is to know what will happen.


I've seen it argued that making its export sector more competitive would not be the primary motivator for the Chinese to devalue the yuan. Rather, it would be an attempt to stem the capital outflows, with estimates that up to US$185b moved out just in this month. Re the export angle the argument is that international trade in the products that China produce is very soft at the moment because most economies are suffering from concerns about deflation (perhaps an indicator of this is the BDI collapsing in the last year to record lows) and that anyway China is no longer an export driven economy (since 2008 its growth is more to do with construction and infrastructure).


But it is probably right that any significant devaluation of the yuan, whatever the mix of reasons, would send shock waves through China's international competitors and suppliers. For instance a 20% devaluation of the yuan would make Chinese produced iron ore 20% more competitive against Australian iron ore. Our manufacturing industry is already effectively gutted (a victim of a severe case of Dutch disease) but anything still going will also be poleaxed imo.


How Australia's free floating currency has worked since it was introduced in the 80's is that a lower Aussie SHOULD act as a shock absorber, which explains why when things go pear shaped for us our currency plunges but our economy remains relatively resolute (for instance we were about the only developed economy not to go into recession during the GFC but the Aussie shat itself). I have to say though that that mechanism does not appear to be working so well currently. Our major strength since the GFC, iron ore, coal and increasingly gas, have been in the pits for months now. We have about the highest real estate prices (relative to incomes) in the world (but for HK) and whilst our public debt is not relatively high we have the highest private debt levels in the world. And yet our currency has "only" fallen about 30% from when the commodities super cycle was at its peak. I suspect that a 20% devaluation of the yuan may be the trigger for the Aussie to find fair value pretty quickly but I am not sure that the Chinese authorities will actually devalue the yuan in one giant step (???).

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Here is the latest piece by George Magnus.


Remember playing backyard cricket with that kid that would only play if he could bat and as soon as he got out he didn't want to play anymore? Well to me that is pretty much the attitude of the Chinese authorities: they are all for markets and deregulation but only if developments go the way they planned. As soon as things do too far off-road though the Chinese will likely take their bat and go home (of course the American banks play the same way in that they demand to be able to privatise the profits and nationalise the losses but they are not central to the western democratic capitalist system (as much as they would like to think they are)) the way the commies are to the current Chinese system.


Here are a couple of observations from Mr Magnus regarding the future of the yuan, and his logic entirely swings on the fundamental primacy of the Chinese Communist Party.


... [W]atch the Yuan. Management of the Yuan may ostensibly lie in the hands of the economically sound PeopleÃÆâ€â„¢ÃƒÆ’ƒâہ¡ÃƒÆ’‚¢ÃƒÆ’¢Ã¢Ã¢Ã¢Ã¢â€š¬Ã…¡Ãƒâ€šÃ‚¬ÃƒÆ’…¡Ãƒâہ¡ÃƒÆ’‚¬ÃƒÆ’¢Ã¢Ã¢Ã¢Ã¢â€š¬Ã…¡Ãƒâ€šÃ‚¬ÃƒÆ’…¾Ãƒâہ¡ÃƒÆ’‚¢s Bank of China, but the strategy call lies with non-experts elsewhere. For now, things have quietened down. I discount the idea that the Yuan will be floated, because this would be to lose control.


The options are a drip-feed depreciation against a strong US dollar, while keeping the basket value stable, the least contentious. Or a small 5-10% devaluation that only serves to trigger more capital flight and depreciation expectations. Or a large 20-40% devaluation that sets off financial instability in China and around the world. We might get all three, in that sort of sequence, but if you twist my arm, IÃÆâ€â„¢ÃƒÆ’ƒâہ¡ÃƒÆ’‚¢ÃƒÆ’¢Ã¢Ã¢Ã¢Ã¢â€š¬Ã…¡Ãƒâ€šÃ‚¬ÃƒÆ’…¡Ãƒâہ¡ÃƒÆ’‚¬ÃƒÆ’¢Ã¢Ã¢Ã¢Ã¢â€š¬Ã…¡Ãƒâ€šÃ‚¬ÃƒÆ’…¾Ãƒâہ¡ÃƒÆ’‚¢d go for the limited depreciation option, perhaps the second, but in any event accompanied by the tightening of exchange and capital controls, and the rollback of financial liberalisation. Control, after all, is the raison dÃÆâ€â„¢ÃƒÆ’ƒâہ¡ÃƒÆ’‚¢ÃƒÆ’¢Ã¢Ã¢Ã¢Ã¢â€š¬Ã…¡Ãƒâ€šÃ‚¬ÃƒÆ’…¡Ãƒâہ¡ÃƒÆ’‚¬ÃƒÆ’¢Ã¢Ã¢Ã¢Ã¢â€š¬Ã…¡Ãƒâ€šÃ‚¬ÃƒÆ’…¾Ãƒâہ¡ÃƒÆ’‚¢etre of the Party.



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Some of the biggest names in the hedge-fund industry are piling up bets against China's currency, setting up a showdown between Wall Street and the leaders of the world's second-largest economy.


Kyle Bass's Hayman Capital Management has sold off the bulk of its investments in stocks, commodities and bonds so it can focus on shorting Asian currencies, including the yuan and the Hong Kong dollar. It is the biggest concentrated wager that the Dallas-based firm has made since its profitable bet years ago against the US housing market. About 85 per cent of Hayman Capital's portfolio is now invested in trades that are expected to pay off if the yuan and Hong Kong dollar depreciate over the next three years ÃÆâ€â„¢ÃƒÆ’ƒâہ¡ÃƒÆ’‚¢ÃƒÆ’¢Ã¢Ã¢Ã¢Ã¢â€š¬Ã…¡Ãƒâ€šÃ‚¬ÃƒÆ’…¡Ãƒâہ¡ÃƒÆ’‚¬ÃƒÆ’¢Ã¢Ã¢Ã¢Ã¢â‚¬Å¡Ã‚¬Ãƒâ€¦Ã‚¡ÃƒÆ’‚¬Ãƒâہ¡ÃƒÆ’‚ a bet with billions of dollars on the line, including borrowed money.


"When you talk about orders of magnitude, this is much larger than the subprime crisis," said Mr Bass, who believes the yuan could fall as much as 40 per cent in that period.


Billionaire trader Stanley Druckenmiller and hedge-fund manager David Tepper have staked out positions of their own against the currency, also known as the renminbi, according to people familiar with the matter. David Einhorn's Greenlight Capital holds options on the yuan depreciating.

Wall Street Journal


- biggest game in town. We are collateral damage (take it on the AUD chin)

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Here is a suggested alternative to the Chinese doing a hard devaluation of the RMB against the USD. It would involve an arrangement that is similar to what Singapore uses of allowing the currency to trade in a band against a basket of currencies.




Also interesting are the views of Patrick Chovanec on the embedded video clip, who basically argues that it would actually be harmful to the Chinese economy if the yuan were to be devalued as so many, in the west at least, are arguing for. I used to follow Mr Chovanec's blog when he was an academic based in Beijing but these days he is a hired gun on Wall St so he does not share his observations with the hoi polloi so freely.

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Well this is just a mug's game... unless they are talking about quite different metrics it appears that either Bank of America or Goldman's, or quite possibly both, are devoid of a clue when it comes to monitoring China's performance.


According to ZH - there's where the problem could be right there - BofA is estimating that capital outflow from China in January was around US$38b, the consensus is for outflows of about US$118b, whilst Goldies is talking about a figure just shy of US$200b.


In other words the forecast for this coming Sunday according to the experts is a tropical deluge, misty showers or sleet and whatever the outcome someone will claim bragging rights for their prescience. :weirdsmiley:




The BofA figure would surely burn lots of the Wall St outfits that are shorting the RMB so I reckon the Chinese authorities will favour something of that order, whereas a reported result anywhere near Goldman's estimate would leave lots of Chinese investors stranded during the week off they have for lunar new year.


The Aussie is looking strong this morning so maybe misty showers it is.


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Here is the latest Bloomberg piece from Guangzhou based academic, Christopher Balding:




and here is an addendum to that article, on his own blogsite.




He clearly thinks that the best option for China is for them to float the RMB. Counter to this an older perhaps wiser head in George Magnus argues that the very purpose of the Chinese Communist Party is control and were they to float the currency they would have to give up a lot of control.



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The January foreign reserves burn rate for China was released yesterday. It came out conveniently just under another three digit drop at US$99.5b. Accepting that that figure would have been manufactured it is substantially under the consensus figure reported by ZH and others of $118b, miles way less than Goldman's prediction and way more than BofA's guess.


As this follow up piece from ZH indicates it probably means that the figure leaves everyone in the zone of unknowing which probably means that for the time being people will remain jumpy and spooked.




Someone posted in the ZH comments section the Chinese have been on a major buying spree in the US in recent times so of course there has been substantial outflows. But if anything it just reminds me of the massive buying spree the Japanese went on just before they lost a couple of decades of economic growth.

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Here's another take on the giant wedgie that China finds itself with: this one is from the angle of the consequences of the US Fed talking up interest rates over the last 18 months or so.


The writer does not entirely blame the yanks for the Chinese predicament and clearly identifies that slowing growth and rising debt have already put China in a bad place. But he argues that the ongoing talk by the Fed of raising rates and then the actual rate rise in December have amplified the problems. I'm surprised he did not note that back in September when many expected the Fed to move the Chinese did their 2% devaluation. I would argue that by acting when they did the Chinese attempted to block the Fed from raising rates. As it turned out however even the notion that the Fed would move may have been enough to cause capital outflows from China.




(hat tip macrobusiness)


All in all though I think the article is a reasonable guess at what is happening. And even though the writer acknowledges that some of his thinking was influenced by Michael Pettis and FT he does not hat tip George Magnus who a couple of weeks ago wrote a similar piece but from the angle of China's leadership. Magnus thinks that the Chinese decision makers will, initially at least, go for whatever option that maintains the most control whereas this writer, David Beckworth, suggests that they may opt for a major devaluation.


To me a major devaluation would be like sending the tanks into Tiananmen Square: if the Chinese leadership is feeling threatened enough they may go for it (but probably not).



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I thought it worth noting how prescient Jim Chanos has turned out to be with regards capital flight from China and the probability of the yuan coming under attack. This from October 2014:


Hedge fund manager Jim Chanos, who has a long-running bet against China, said that the country's credit bubble was starting to cause capital outflows to accelerate and may ultimately lead to weakness in the nation's currency.




Kyle Bass and George Soros and numerous others have been everywhere of late with their calls that China is in for a hard landing but it was Mr Chanos who has been shorting proxies of China for a good couple of years now. From memory he was shorting the likes of BHP from the time such stocks were going gangbusters.


Mr Chanos still appears to hold the same assessment of China as he did a few years back but for whatever reason he now gets treated as just another hedge fund manager.

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Here are links to new columns by George Magnus and Christopher Balding.






They both seem to agree that from the perspective of the Chinese Communist Party tighter capital controls may be more politically acceptable and that sooner or later the Chinese leadership may have to bring about a substantial devaluation of the RMB (and I see that Mr Magnus is thinking along the lines of a 40% devaluation whereas most other commentators I've come across are still talking of a devaluation in the region of 20%-30%).


But whereas Prof Balding attempts to argue that a major devaluation would not be that disruptive Mr Magnus suggests that not only would a devaluation undo much of what progress has been made to date in rebalancing the Chinese economy but perhaps more decisively it would be "politically dangerous" for the ruling party.


My own garbled view is that whereas Prof Balding's argument that the Chinese would only be putting off the inevitable by relying at first instance on tighter capital controls the reality is that China is not the only moving part in this drama. Clearly the oil exporting and commodity based economies are in a world of pain, Euroland looks to be headed back into a financial crisis and the US looks set for much political instability in the year ahead, any of which could blow up before the Chinese hit the wall with regards their liquid foreign reserves.


I remember during the Asian crisis in the late 90's for a long period of time the Hong Kong authorities insisted that the territory was above it all and that HK would continue to power ahead. When the crash eventually hit the HK market and economy full on the Financial Secretary, Donald Tsang, did the outrageous thing of fighting the market's downward momentum by buying up a big chunk of stock listed on the HK exchange (the Malaysians did a similar thing). It was generally viewed as an exercise in futility, ignorance and arrogance destined to lose the HK Treasury billions. But then out of the blue Russia defaulted which acted as a circuit breaker for the death spiral in east Asia and Tsang's reckless gamble turned out to be a master stroke.


I've seen it argued that Uncle Vlad is hoping that his actions in bombing civilian areas in Syria thus causing a stampede of refugees (and others) into Europe will cause such a political and financial crisis in the EU that they will relent on the sanctions imposed on Russia regarding its actions in Ukraine and Crimea. The argument goes that the removal of the sanctions will give Russia more room to see through the current stage in the oil price cycle. It may well be that China also calculates that if they can use tighter capital controls to put off freeing up or devaluing the RMB then a crisis elsewhere may negate the need for such action.

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